What are Alternative Investments? Definition, Examples, Risks

Alternative investments have become an interest among investors who want more than the usual mix of stocks, bonds, and cash. But before diving into the examples, let’s step back and ask the most basic question: What are alternative investments? In essence, they represent an asset class that exists in the sectors outside the conventional bond and stock markets.

Key Takeaways

• Alternative investments are non-traditional assets that go beyond stocks, bonds, and cash, offering opportunities for diversification, higher returns, and inflation hedging.
• Real estate, private equity, hedge funds, commodities, art, and cryptocurrencies are among the most common alternative investments.
• Alternative investment needs proper planning and awareness of the dynamics and trends in the markets.

This article walks you through what alternative investments actually are, the different forms they take, and the trade-offs to weigh before deciding whether they should belong in your investment strategy.

What is an Alternative Investment?

When people ask what are alternatives in investing, they’re usually referring to financial assets beyond stocks, bonds, and cash. These “non-traditional” investments have surged in popularity as investors look for ways to diversify beyond the increasingly unpredictable public markets. In fact, alternative assets under management have already exceeded $33 trillion, according to J.P. Morgan Research.

Despite that momentum, only a small segment of Americans have actually dipped their toes into alternative investments. In a survey cited by USA Today, fewer than 10% of the population invest in alternative investments, although interest in the space has, in fact, been high among the younger segments.

Alternative Investments vs. Traditional Investments

When comparing alternative investments to traditional ones, the biggest difference lies in familiarity and accessibility. Traditional assets (think stocks, bonds, and cash) are widely understood, easily traded, and highly regulated. They’re typically more liquid, meaning you can buy or sell them quickly without much friction. Because of these characteristics, they form the core of most portfolios and are often the first stop for new investors.

Alternative investments, on the other hand, operate outside this conventional framework. Alternative investments encompass other types of assets like property, private equity, hedge funds, venture capital, commodities, and some emerging areas, such as cryptocurrency and fractional ownership. These types of investments tend to offer lower levels of liquidity, longer investment horizons, and possibly complex strategies. But they provide other things that typical investments don't, like alternative risk and those related to protecting against inflation.

Types of Alternative Investments

Understanding what are the main types of investment alternatives is essential for anyone looking to diversify beyond the usual mix of stocks and bonds. Here are the examples of alternative investments:

Real Estate

Alternative real estate investments entails the purchasing of property, either commercial or residential, in hope that the property increases in value. One may invest in the property directly and another way through Real Estate Investment Trusts (REITs) or online fractional real estate platforms like Concreit.

Private Equity

Private equity involves investing in private companies or buying out public companies to make them private. Investors in private equity typically invest in a private fund managed by a firm. These funds invest in a portfolio of private companies and investors earn returns as the value of these companies increases. Private equity investments offer the potential for high returns but come with higher risks and illiquidity.

Hedge Funds

Hedge funds are investments whereby the funds are managed using different strategies in order to make gains. Some strategies include stock, bond, and other forms of assets. The funds can make use of leverage and short selling. These types of funds are usually available to accredited investors and charge higher fees compared to mutual funds.

Private Credit

Private credit deals with loans provided by non banking financial institutions, including private funds and institutional investors, and not the banks. Private credit has recorded growth due to the need by businesses to access funding beyond the regulations applied by banks. Private credit can fall under direct lending, mezzanine finance, distressed debt, and specialty finance.

Commodities

Commodities refer to physical materials such as gold, oil, farm products, etc. that are traded on commodities exchange. There are a couple of ways through which an individual can invest in commodities. Those include futures and commodities ETFs/mutual funds. Commodities act as an instrument through which the risk of an increase in inflation can be diversified  (Investopedia).

Art and Collectibles

Art and collectibles would include artwork, antiques, coins, precious metals, and other collectibles, where there would be an expectation of their value appreciating in the future. These would include assets where there are risks and lack of liquidity.

Cryptocurrencies

Cryptocurrencies are digital currencies that rely on cryptography. Bitcoin is the most well-known, and there are several others. The process of investment in cryptocurrency includes the use of crypto exchanges. The returns on cryptocurrency are high and come with high risks.

Structured Products

These usually involve fixed income markets and derivatives. Examples include credit default swaps (CDS) and collateralized debt obligations (CDO). Structured products can be complex and sometimes risky investments but offer investors a customized product mix to meet their individual needs.

Related: Alternative Investment for Your Retirement Portfolio

How to Invest in Alternative Investments

Understanding what are considered alternative investments can help you find options that better match your goals, risk tolerance, and long-term strategy. The good news is that investors today have more ways than ever to access alternative assets. 

1. Real Estate: Investors can invest in real estate by buying properties directly, investing in REITs, or investing through real estate crowdfunding platforms. Platforms like Concreit allow retail investors to invest in a diversified portfolio of real estate properties with low minimum requirements.
2. Private Equity: Investors can invest in private equity through private firms, venture capital funds, or crowdfunding platforms. The purpose behind the formation of such equity is that it pools funds from different individuals and invests in other private companies.
3. Hedge Funds: Invest directly in a hedge fund managed by a professional. Hedge funds are usually available only to accredited and institutional investors.
4. Private Credit: Invest through private credit funds or direct lending platforms. The platforms allow pooling funds from investors to provide loans to businesses.
5. Commodities: Invest in commodities by purchasing commodities themselves, futures contracts, or commodity exchange-traded funds/mutual funds.
6. Arts and Collectibles: Buy or invest in art, wines, classic cars, stamps, and coins, with the hope that they’ll increase in value.
7. Cryptocurrencies: Begin with selecting a trustworthy crypto exchange platform, generate an account, and deposit funds. Then, invest in cryptocurrencies such as Bitcoin, Ethereum, and other coins.
8. Structured Products: You can invest through financial institutions/brokers, usually structured in accordance with the needs of the investors.

Pros and Cons of Alternative Investments

Alternative investments often come with their own set of benefits and challenges. Below, we discuss some of the key advantages and disadvantages of alternative investments.

Potential Benefits of Alternative Investments

• Portfolio Diversification: Given the increased volatility in the stock market and the potential for substantial losses, spreading risks across different asset classes is an appealing strategy (Yahoo Finance).
• Potential for Higher Returns: A study by Bank of America reveals that 75% of Americans doubt the possibility of achieving above-average returns solely through traditional stocks and bonds.
• Hedge Against Inflation: Alternative assets, including real estate, gold, and fine wine, are generally considered strong hedges against inflation.
• Access to Unique Opportunities: Investing in alternatives allows exposure to niche markets, startups, and tangible assets not available in public markets.
• Risk Management: By spreading investments across different asset classes, investors can manage risk more effectively in volatile markets.

Potential Risks of Alternative Investments

• Higher Fees and Transaction Costs: The cost involved in alternative investing is higher compared to other types of investment.
• Higher Risk: These types are viewed as high risk because they are complex, lack government regulations, and involve uncertainties.
• Lack of Regulation or Transparency: The regulations on alternative investment funds are less well-articulated than those applied to other forms of investment. Majority are also offered only to institutional and accredited investors.
• Illiquidity: These types of investment lack the characteristic of liquidity and, hence, cannot be sold quickly.
• Valuation uncertainty: There could be some uncertainties in the valuation of the assets.

Alternative Investment Strategies

Investors approach alternative investments with a variety of strategies depending on their risk tolerance, investment horizon, and desired returns. 

Direct Investment

Direct investment means the actual purchase of alternative assets like property, artwork, or commodities. The advantage could be the management and possible returns, which come with high capital and knowledge costs. Liquidity can be limited, as selling these assets may take time.

Fund-Based Investment

Fund-based investment pools capital from multiple investors into structured vehicles such as private equity funds, hedge funds, or venture capital funds. These models offer high-value investment opportunities with professional management, diversification, and the ability to generate high returns, though at high costs and substantial minimum investment. 

Long/Short and Market-Neutral Strategies

Some alternative investors use long/short strategies, buying undervalued assets while shorting overvalued ones to profit from price differences. Market-neutral approaches aim to minimize exposure to market-wide risk, focusing instead on relative performance between assets. 

Choosing the right strategy depends on factors such as risk tolerance, investment horizon, liquidity needs, and sector expertise. Regardless of approach, alternative investments demand careful due diligence, ongoing monitoring, and an understanding of potential risks and returns. 

Regulations for Alternative Investments

Alternative investments often operate in less regulated environments than traditional securities, but regulatory oversight exists to protect investors and maintain market integrity. For instance, in the U.S., the Securities and Exchange Commission (SEC) oversees certain private equity and hedge fund offerings under the Investment Advisers Act of 1940, while the Commodity Futures Trading Commission (CFTC) monitors commodity and derivatives markets. 

Globally, regulations differ: the European Securities and Markets Authority (ESMA) sets guidelines for alternative investment fund managers in Europe. Investors should note that regulations often affect liquidity, reporting requirements, and the types of investors allowed (typically accredited or institutional). 

Tax Implications for Alternative Investments

Tax treatment of alternative investments varies widely depending on the asset type, jurisdiction, and investment structure. Real estate and collectibles may be subject to capital gains taxes, while certain private equity or hedge fund investments can generate passive income or carried interest, which may receive preferential tax treatment. 

Cryptocurrencies are often treated as property, meaning every sale or exchange can trigger a taxable event. Understanding these implications is critical, as alternative investments can carry more complex tax reporting requirements compared to traditional stocks and bonds. Consulting a tax professional is highly recommended before committing capital to these assets.

Real Estate as an Alternative Investment

Investing directly in real estate typically involves buying, managing, and selling properties, which can be both expensive and time-consuming. Many investors already have exposure to real estate through homeownership, and combining this with a diversified portfolio of stocks and bonds—including REITs and mortgage-backed securities—can provide substantial real estate exposure.

The alternative investment industry has evolved significantly with the rise of online platforms like Concreit, which have made real estate investing more accessible to a broader audience. Today, even young or first-time investors can explore and participate in real estate and other alternative assets with relative ease, opening doors to opportunities that were once limited to high-net-worth individuals or institutions.

Conclusion: Diversify Your Portfolio with Alternative Investments

Understanding what are alternative investments is key to building a well-rounded and resilient portfolio. Unlike traditional stocks, bonds, or cash, alternative assets such as real estate, private equity, commodities, and cryptocurrencies offer unique opportunities for diversification, potential higher returns, and protection against market volatility and inflation.

While these investments may carry higher risk or require specialized knowledge, incorporating them thoughtfully can strengthen your overall investment strategy. By exploring what the alternative investment industry has to offer and aligning choices with your financial goals and risk tolerance, you can create a more balanced, future-proof portfolio that goes beyond conventional investment approaches.

Frequently Asked Questions (FAQs)

What are liquid alternative investments?

Liquid alternative investments are alternative assets that can be easily bought or sold without significant loss of value. Examples include publicly traded REITs, commodity ETFs, and certain hedge fund-like mutual funds, which provide exposure to alternative investing strategies while maintaining higher liquidity than private assets.

What is the most popular alternative investment?

Real estate is generally considered the most popular alternative investment, followed closely by private equity, hedge funds, and commodities. Their tangible nature, income potential, and historical resilience make it appealing to a wide range of investors.

Is ETF an alternative investment?

While many ETFs track traditional stocks and bonds, certain ETFs provide exposure to alternative assets like commodities, real estate, or cryptocurrency. These are often referred to as “liquid alternatives” and allow investors to participate in alternative strategies through a familiar, easily traded structure.

How do alternative investments work?

Alternative investing works by providing exposure to asset classes outside traditional stocks, bonds, and cash. They may generate returns through income (like rent or interest), capital appreciation, or speculative strategies, depending on the type of investment. Risk, liquidity, and management requirements vary widely across different alternatives.